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The Financial Crisis of 1929
Reexamined: The Role of Soaring
Inequality
Jon D. Wisman
a
a
American University, Washington, DC, USA
Published online: 19 Jun 2014.
To cite this article: Jon D. Wisman (2014) The Financial Crisis of 1929 Reexamined: The Role of
Soaring Inequality, Review of Political Economy, 26:3, 372-391, DOI: 10.1080/09538259.2014.915153
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Review of Political Economy, 2014
Vol. 26, No. 3, 372– 391, http://dx.doi.org/10.1080/09538259.2014.915153
The Financial Crisis of 1929
Reexamined: The Role of Soaring
Inequality
Downloaded by [American University Library] at 10:49 04 August 2014
JON D. WISMAN
American University, Washington, DC, USA
(Received 15 May 2013; accepted 20 December 2013)
ABSTRACT The financial crisis of 1929 that triggered the Great Depression has been
endlessly studied. Still there is little consensus regarding what caused it. This article
claims that wage stagnation and exploding inequality fueled three dynamics that set the
stage for a financial crisis. First, consumption was constrained by the smaller share of
total income accruing to workers, thereby restricting investment opportunities in the
real economy. Flush with greater income and wealth, the elite flooded financial markets
with credit, helping keep interest rates low and encouraging the creation of new credit
instruments, some of which recycled the rich’s surplus assets as debt to those less well
off. Second, greater inequality pressured households to find ways to consume more in
order to maintain their relative social status, resulting in reduced household saving,
greater household debt, and possibly longer work hours. Third, as the rich took larger
shares of income and wealth, they gained relatively more command over everything,
including ideology. Reducing taxes on the rich, favoring business over labor, and
failing to regulate newly evolving credit instruments flowed out of this ideology.
1. Introduction
The Great Depression looms large in US history and has been studied extensively.
Yet there is little consensus as to why it happened. This article sets forth an explanation that looks toward political and social economics. From this broader perspective the Great Depression can be understood as the result of wage
stagnation and exploding inequality during the 1920s. These factors also contributed to the Depression’s duration.
Many studies of the 1929 financial crisis have agreed that low interest rates,
financial innovation, indebtedness, excessive speculation, and laissez-faire
Correspondence Address: Jon D. Wisman, American University, Washington, DC, USA, Email:
jdwisma@american.edu
# 2014 Taylor & Francis
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The Financial Crisis of 1929 Reexamined
373
ideology supporting lax regulation played important causal roles. While this analysis is not incorrect, it addresses proximate causes.1 Beneath these, preconditions for
the crisis were being set by wage stagnation and dramatically growing inequality.
Given the importance Keynes assigned to inequality in accounting for
inadequate aggregate demand, it is surprising that so little attention has been
given to it, much less growing inequality, as a causal factor of the 1929 crisis.2
A glance at influential treatises on the Great Depression (Bernanke, 2000; Friedman & Schwartz, 1963, 1965; Temin, 1976, 1991) finds no mention of rising
inequality as a cause of that crisis.
While most studies of the 1929 crisis ignore the role of increasing inequality,
scholars in the Keynesian/Kaleckian underconsumptionist tradition have recognized the importance of rising inequality for aggregate demand, given that the
marginal propensity to consume is lower among high-income households than
low-income households (Galbraith, 1954; Hughes, 1987; Faulkner, 1960; Potter,
1974; Livingston, 1994, 2009; Stricker, 1983– 84). While the analysis of this
article relies on the Keynesian/Kaleckian underconsumptionist school, it offers
a broader perspective by drawing upon Thorstein Veblen’s theory of consumer behavior and Karl Marx’s theory of ideology. These theoretical perspectives clarify
how declining labor power and greater inequality generated three dynamics that
heightened conditions in which a financial crisis might occur.
The first was how the threat of inadequate demand resulting from greater
inequality was countered by two forces, a fall in household saving, and increased
household indebtedness. This rise of indebtedness was abetted by financial
markets that were flooded with credit, thereby keeping interest rates low and
encouraging the creation of new credit instruments. This first dynamic draws its
explanatory framework from structural explanations in the theoretical tradition
of Marx, Keynes, Kalecki and Minsky.
The second dynamic was the consumption response of non-elite households
to smaller relative income shares. As the wealthy ratcheted up their consumption,
especially on homes, automobiles, and other newly evolving consumer durables,
consumption externalities put pressure on those below to consume more to maintain their relative social status, social respectability, and thus their self-respect. To
do so, households saved less, augmented their indebtedness, and perhaps increased
their work hours. This second dynamic draws upon Veblen’s theory of consumer
behavior, which provides a deep understanding of the manner in which rising
inequality affects household behavior.3
1
For example, White (1990, p. 67) notes that ’many of the hypotheses offered to explain the 1929
boom and bust . . . played trivial or insignificant roles [and his evidence] favors that a bubble was
present in the 1929 market,’ but he does not provide an explanation for why a bubble evolved.
2
What makes this even more surprising is that well before Keynes the role of rising inequality in
reducing consumption (and thus production) was recognized by many earlier economists.
Already, at the end of the 17th century, Pierre de Boisguilbert (1695) noted that the distribution
of income in favor of the rich, who would hoard much of it, and away from the poor, who would
spend it, contributed to the disastrous decline of the French economy during the reign of Louis XIV.
3
Veblen’s theory of consumer behavior has been all but ignored by mainstream economics. James
Duesenberry drew upon Veblen to explain the empirical problems faced by Keynes’ consumption
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374 J.D. Wisman
The third dynamic is that possessing a larger share of society’s resources
gave the wealthy increasing command over political ideology. This legitimated
laissez-faire economics and busting labor’s bargaining power. Reducing the size
of government, tax cuts for the rich, deregulating the economy, and failing to
regulate new credit instruments flowed out of this ideology. Further, political
attention was diverted from economic to cultural issues. The 1920s saw political
combat over such issues as evolution, prohibition, immigration, and the increasingly militant Ku Klux Klan. This third dynamic—the greater command over
social ideology by the rich as inequality rose—has its roots in Marx’s theory
of ideology.
The buildup to the financial crisis of 1929 was novel. Financial crises had
been endemic to capitalism from its early days. Recovery was usually quick
because, beyond the unemployment, the major consequence was the destruction
of paper wealth held by a small wealthy elite. What was novel and what distinguishes the crisis of 1929 (and that of 2008 eight decades later) is that the speculative mania preceding it occurred not only in the stock markets but in the real
estate market as well. Real estate markets are more democratic than stock
markets in that a larger share of the population, by taking on debt, participates
in ownership, and thus the collapse of a speculative bubble in real estate has consequences that are far greater and longer lasting.4 In addition, real estate ownership possesses a social characteristic that is special; for many households it
constitutes not only the most important store of wealth, but also the most important
symbol of social status.
2. Busted Labor and Rising Inequality
The industrialization of the United States unleashed forces that dramatically
increased inequality, conforming to a dynamic that Kuznets (1955) believed
accompanied the early phase of economic development. The increase in inequality
after the Civil War, although continual, witnessed two surges. The first began at
the end of the Civil War and lasted until about 1900. The second surge began
at the end of the First World War and lasted until the late 1920s.
The economy appeared robust and healthy in the 1920s. Annual economic
growth averaged 5.9% from the end of the July 1921 recession and August of
1929, despite two mild recessions (in 1923– 24 and 1926–27); this was an extraordinary performance compared with the long-run average rate of 3.0% (Hall &
Ferguson, 1998, p. 17). Over the decade of the 1920s, the unemployment rate averaged 3.7% (White, 1990, p. 69).
function. However, as Taylor (2010, p. 227) points out, ‘it lacked rational actor “foundations,” which
is the main reason why it has almost completely disappeared from view.’
4
Gjerstad & Smith (2009) support a similar interpretation: ‘The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of
the wealth and income distribution can be transmitted quickly and forcefully into the financial
system . . . [and] It appears that both the Great Depression and the current crisis had their origins
in excessive consumer debt—especially mortgage debt—that was transmitted into the financial
sector during a sharp downturn.’ They do not link this debt to rising inequality.
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The Financial Crisis of 1929 Reexamined
375
However, labor’s relative power was falling. Popular support for labor weakened and union membership declined from 17.4% in 1921 to 10.5% by 1929
(Ohanian, 2009, p. 2320), and annual average productivity gains of 5.44%
between 1919 and 1929 greatly outpaced wages (Smiley, 2010, p. 9). The distributional consequences conformed to Long’s (1960, p. 112) claim that ‘So large is
labor’s share of national income that any substantial disparity between productivity and real wages would exert great impact on the other shares—either
largely expropriating them or presenting them with huge windfalls.’
During the 1920s, with its bargaining power compromised, labor confronted
technological innovations that were predominantly labor-saving and concentrated
in manufacturing, causing a shift in demand from unskilled to more skilled labor.5
Low-skilled assembly-line workers were being replaced by labor-saving capital
while the demand for more skilled workers such as machine repairmen increased,
resulting in lower wages for the former relative to the latter (Hall & Ferguson,
1998, p. 21).6 Although total manufacturing output increased by 64% during the
decade, the total number of workers in that sector remained almost constant
(Stricker, 1983, p. 22), resulting in the share of wages in manufacturing revenues
declining from 52% in 1922 to 43% in 1929.7 Between 1923 and 1929 weekly
earnings declined about 20% in manufacturing (Bernstein, 1966, pp. 66 –67).
Increasing productivity flowed almost exclusively to corporate profits, increasing
them 62%, enabling dividends to double.
The windfalls for the rich resulting from wages lagging behind productivity
growth were further nourished by tax ‘reforms’ that reduced corporate taxes and
lowered the maximum personal income tax rate. President Calvin Coolidge energetically campaigned to drastically cut taxes on the highest incomes, and the large
tax cuts undertaken in 1921, 1924, and 1926 benefited only the wealthy. Marginal
tax rates as high as 75% were reduced to 25% (Smiley, 1998, p. 218).8 In 1926 the
gift tax was repealed and, in 1928, the estate tax was cut by one-half. Although
these taxes were raised to support the war, had the pro-labor Progressive Era political values survived into the 1920s, social programs might have been expanded
in lieu of tax cuts for the rich.
The soaring increase in inequality can be glimpsed in the following statistics:
according to Piketty & Saez (2010, Table A2), between 1920 and 1929 the income
share taken by the richest decile increased from 38.76% to 44.29%, while that of
the top one percent increased from 14.71% to 19.90%. The Gini coefficient for
family income rose from 0.48 in 1919 to 0.57 in 1929 (Plotnick et al., 1998,
5
Western (2004, p. 166) notes that a high-tech revolution led by companies such as RCA during the
1920s gave the period a character not unlike the late 1990s.
6
Williamson & Lindert (1980, p. 247) estimate that technological innovation during the 1920s
increased the premium for skilled labor by 0.98% per year.
7
Bernstein (1998, p. 198) finds that wages as a percentage of value-added in manufacturing fell from
45.0 in 1923 to 36.9 in 1929.
8
These tax cuts foreshadowed repercussions for aggregate demand. Galbraith (1979, pp. 29 –30)
notes that ‘As practical experience with past tax reduction has shown (and as was duly reported
by the Council of Economic Advisors), the initial effect of a cut in personal taxes is overwhelmingly
to increase savings.’
376 J.D. Wisman
Appendix D). Between 1919 and 1929, the real per capita income of workers
increased at an average rate of $5.64 per year, or 2.56% for the whole period
(Smiley, 1998, p. 224). The share of total wealth held by the top 1% rose from
36.7% to 44.2% (Wolff, 1996). Phillips (2002, p. 11) estimates that whereas
there were about 7,000 millionaires in 1921 –1922, by 1929 there were about
30,000. The real prosperity of the 1920s was reserved for those at the top of the
income scale (Bernstein, 1966; Stricker, 1983).
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3. Inequality, Weak Aggregate Demand and Speculative Excess
The increased share of income and wealth going to the rich was far greater than
could be spent, even on the most lavish consumption.9 Whereas in 1922 the top
1% of income recipients accounted for 49% of total US saving, by 1929 they
accounted for 80% (Hall & Ferguson, 1998, p. 21).10 These additional savings
sought high rates of return. The fact that those who spend most of their income
had a smaller share of total income to spend, profitable investment potential in
the real economy was limited. Suggesting inadequate consumer demand, Hall &
Ferguson (1998, p. 18) claim that the mild deflation during the 1920s (an
average of about 0.5% per year between 1921 and 1929) was traceable to the
fact that the expansion in aggregate supply outpaced increases in aggregate
demand. As a result, funds flowed into the financial sector, where they increased
employment by 400,000 between 1925 and 1929 (Stricker, 1983– 84, p. 53).
Although new consumer durables (such as automobiles, refrigerators, electric
irons, and radios) were driving the early twentieth century economy, rising
inequality during the 1920s constrained demand for these products.11 Lower
household saving and the expansion of installment credit permitted continuing
spending, although rising indebtedness meant that this would ultimately be
limited by reduced creditworthiness. Short-term personal loans soared by more
than 1,200% during the 1920s. Non-mortgage consumer debt doubled, rising to
$7.6 million by 1929, or 9.3% of income (Olney, 1999, p. 321).12
Even major automobile companies were setting up financial divisions to
make loans for the purchase of their cars. By 1927, two-thirds of new cars were
purchased on credit (Eichengreen & Mitchener, 2004, pp. 203, 214). Stricker
(1983– 84, p. 55) concludes that ‘Consumption-demand lagged behind potential
output of consumption goods, and only installment credit and upper-class
9
Nevertheless, they did spend prodigiously: ‘the top 10 percent made 36 percent of all food expenditures and 50 percent of all expenditures on non-essential items like recreation, health, and education’ (Stricker, 1983, p. 8).
10
Stricker (1983–84, p. 50) reports that by 1929, the top decile of income distribution had 86% of
total household savings, and thus the bottom 90% accounted for only 14%.
11
Durable goods spending increased from 4% of total spending in the 1898 –1916 period to 7.6% in
the 1922–29 period (Olney, 1991, p. 25).
12
There was very little regulation of new credit instruments. Although the Progressive Era saw the
rise of regulatory agencies, after the war, the regulated exercised increasing control over the regulators. There appears to have been predatory lending, with ‘the effective rate of interest . . . generally
in the neighborhood of 30 to 40 percent but sometime ranged as high as 100 percent for installment
contracts’ (Olney, 1999, p. 322).
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The Financial Crisis of 1929 Reexamined
377
consumption smoothed over that problem for a while.’ What was occurring was
that a portion of the greatly increased share of income and wealth accruing to
the elite was being recycled to those below as debt.
The negative impact of rising inequality on investment opportunity in the real
economy was augmented by robust increases in productivity, resulting in declining investment even as output expanded. Investment in plant and equipment
declined from $15.5 billion in 1926 to about $14.5 billion annually over the
next three years. Investment in construction also declined in the late 1920s
(Stricker, 1983 –84, pp. 51– 52). Livingston (1994, pp. 114–115) reports that
‘According to Moody’s Investors Service . . . the proportion of net new corporate
securities issues which was used “productively,” for capital construction, declined
from 62 to 29 percent between 1924 and 1929.’ Suggesting a dearth of good
investment options for retained earnings, dividends as a share of national
income rose from 4.3% in 1920 to 7.2% 1929. About 82% of these were paid
to the wealthiest 5% of Americans (Hall & Ferguson, 1998, p. 21).
Investment funds moved from the production sector to the financial sector,
stimulating innovations in credit instruments and speculation. This nourished a
real estate bubble that burst prior to the subsequent speculative frenzy in the
stock market. As households below the top struggled ever-harder to maintain
their relative social status, they became more indebted as a portion of the enlarged
income and wealth of the elite was recycled to them through these more sophisticated financial markets.
Thus, despite a drop in the share of income of those with the highest marginal
propensity to consume, economic growth continued. In Kalecki’s terms, growth
appeared to be profit-led as opposed to wage-led.
The financial crisis of 1929 came as a surprise because the dominant focus
was on surface reality—the fact that growth was robust and price deflation
mild. However, beneath this surface, wage stagnation and rising inequality
shifted investment from production to finance and speculation, giving poignancy
to Keynes’s (1936, p. 159) observation that ‘Speculators may do no harm as
bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes a bubble on a whirlpool of speculation.’ During the 1920s, speculative excesses occurred in two different sectors—first in real estate, which
crashed in 1926, and then in the stock market, which crashed three years later.
3.1. Speculative Fever in Real Estate
Before the First World War, households typically purchased homes by borrowing
from family and friends. Urbanization and the expansion of financial institutions,
flush with assets and thus offering attractive credit conditions, encouraged borrowing from institutional lenders. Whereas financial institutions provided about 45%
of financing before the First World War, this rose to about 60% by 1925 (White,
2009, pp. 24– 25). Mortgage lending increased by 55% between 1922 and 1925 as
the real estate market heated up, and mortgage debt rose from $9.35 billion in
1920 to $29.44 billion in 1929. As further evidence of speculation in real
estate, from 1924 until 1927, the ratio of residential housing construction to
GNP was at ‘by far its highest level of the twentieth century‘ (Gordon &
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378 J.D. Wisman
Veitch, 1986, p. 326). White claims that ‘ . . . the nationwide “bubble” that
appeared in the early 1920s and burst in 1929 was similar in magnitude to the
recent real estate boom and bust.’ Residential housing starts reached ‘a peak in
1925 that was not surpassed until 1949.’ The percentage of households owning
homes increased from about 45% to 50%. Commercial banks, insurance companies, and savings and loan associations ‘expanded their total mortgages by 76,
79 and 62 percent’ respectively between 1920 and 1926. Further, there was a
wave of residential and commercial mortgage securitization (White, 2009,
pp. 1, 5, 50, 25 –26, 29).
The bubble was pricked by a severe September 1926 hurricane that created
widespread devastation in Florida, where the boom had been most robust
(Galbraith, 1954). Housing prices that soared about 20% in the early 1920s,
declined by about 10% before the stock market crash. Foreclosures increased
every year between 1926 and 1933 (White, 2009, p. 47). A relative decline in
the demand for consumer durables, especially automobiles, occurred after the
real estate bubble popped in 1926. Although the residential housing market
peaked in 1926, the commercial market continued to boom for the rest of the
decade (White, 2009, p. 31).
3.2. Speculative Fever in the Stock Market
When the real estate market collapsed, investment funds flowed into the stock
market. Indeed, the stock market boom only fully took off when real estate
prices began declining, fueled in part by the explosion of investment trusts
(much like today’s mutual funds), which grew from about 40 in 1921 to more
than 750 in 1929 (Carosso, 1970). Investment trusts were financial innovations
created by banks as ‘off-balance sheet’ entities to shield their speculative activities
from the scrutiny of regulators.
Toward the end of the 1920s, trusts came to hold the stocks of other leveraged
trusts, creating a Ponzi-like structure. An estimated 186 investment trusts were
created in 1928 and another 265 in 1929. Whereas they sold about
$400,000,000 worth of securities in 1927, they sold an estimated $3 billion in
1929 (Galbraith, 1954, pp. 49 –50).13 The Dow-Jones Industrial Index rose from
91.0 in 1922 to 290.0 in 1929, most of this occurring after the real estate bust.
The index rose 29% in 1928 and another 30% in 1929, with 25 percentage
points of the latter occurring in June, July, and August before peaking in September. Trading volume more than doubled in the two years prior to the crash.
In the years before the stock market crash, there was enormous growth in
loans by corporations to brokers who, with interest rates rising, were able to
command higher returns on margin loans to speculators. With inequalityinduced weak aggregate demand, corporations found higher profits in financial
13
Although there were stories of porters and janitors speculating in stock, Galbraith (1954, p. 78)
reports that only one and a half million (less than 2% of the population) ‘had an active association
of any sort with the stock market, and not all of these were speculators . . . only about 600,000 of
these accounts . . . were for margin trading’.
The Financial Crisis of 1929 Reexamined
379
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markets than in investments in the real productive capacity of the economy.
Speculators seemed unfazed by the high real interest rates on brokers’ loans,
and ’individuals were paying 8.56 percent to borrow to buy stocks paying dividend
yields averaging 2.92 percent’ (Hall & Ferguson, 1998, pp. 24 –25).
With credit fueled by tremendous increases in the income and wealth of the
very rich, overly expansionary monetary policy, inflow of foreign monies,14 and
greater use of financial instruments, financial institutions were tempted to take
ever-greater risks.15 As Eichengreen & Mitchener (2004, p. 186) put it, ‘The
credit boom and its ultimate impact were especially pronounced where the organization and history of the financial sector led intermediaries to compete aggressively in providing credit.’
4. Rising Inequality and the Struggle for Status Security
Stagnating wages and rising inequality during the 1920s created consumption
externalities, requiring households to increase spending in order to protect the
welfare of their families and maintain their relative social status. In their struggle
to do so, they decreased savings, became more indebted, and possibly worked
longer hours. The approach followed in this section views preference functions
as at least partially endogenous—to some extent, socially created. It is aligned
with Duesenberry’s (1967, p. 19) view that a ‘real understanding of the problem
of consumer behavior must begin with a full recognition of the social character
of consumption patterns.’
Frank (2000, p. 258) noted that consumption externalities generated by rising
inequality often require households to increase spending for the welfare of their
families:
Increased spending at the top of the income distribution has not only imposed
psychological costs on families in the middle, it has also raised the cost of
achieving many basic goals. Few middle-income parents, for example, would
be comfortable knowing that their children were attending below-average
schools. Yet the amount that any given family must spend to avoid that
outcome depends strongly on the amounts that others spend . . . [Moreover],
people cannot send their children to a public school of even average quality if
they buy a home in a school district in which house prices are well below
average.
A second manner in which, due to consumption externalities, wage stagnation and
rising inequality prompt households to struggle to consume more is well captured
14
Prior to 1929, foreign funds flowed into the US, helping fuel credit expansion. The US and France
required that Germany pay its war reparations in gold, creating a net gold inflow into the US that
increased the availability of credit (Bernstein, 1998, p. 204).
15
Bernstein (1998, p. 197) claims that ‘Margin-buying was the rule not the exception [and] brokers
often allowed as much as 80 percent of the value of a stock purchase to be borrowed . . . frequently
extended in the absence of any formal check on the credit-worthiness of the customer involved.’
Kindleberger (1996) saw easy access to credit as the major ingredient fueling the asset price
bubble. A striking echo resounded some 80 years later in the reckless sub-prime loans that preceded
the crisis of 2008.
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380 J.D. Wisman
by Veblen’s theory of consumer behavior. As rising inequality permits the rich to
consume much more, lower income households have to struggle harder to
consume more to maintain their relative social status and their self-respect.
In the US, there has been widespread belief in vertical mobility. Consequently, Americans have generally felt responsible for their own social status.
Through adequate dedication and effort, anyone can move up, even to the very
highest rungs of social status. It is the individual’s responsibility; it depends
upon the individual’s willingness to work hard. Further, as Brown (1994, p. 8)
notes, ‘Hard work is viewed as being rewarded by vacations, fancy cars, and
second homes. Status markings reinforce the notion that the unequal outcomes
are fair rewards.’
How hard one works in modern society, however, cannot be directly
observed. What catches attention is how much one consumes. This stands, more
or less, as a proxy for how hard one has worked. Thus, because Americans
believed they were individually responsible for their own social standing, they
felt compelled to demonstrate status and class identity through consumption.
Greater inequality means that consumers had to stretch further to maintain their
relative social standing.
An attempt to maintain or increase social standing through consumption is
what Veblen meant by conspicuous consumption, and it manifests itself in two
dimensions. Consumption that permits ‘invidious comparison’ is meant to demonstrate one’s status to be above those below. ‘Pecuniary emulation,’ on the other
hand, refers to the practice of imitating the consumption standards of those of
higher status with the intent of appearing to possess that status. Veblen 1899,
pp. 109– 110) claimed: ‘With the exception of the instinct of self-preservation,
the propensity for emulation is probably the strongest and most alert and persistent
of the economic motives proper . . . [and] the propensity for emulation—for invidious comparison—is of ancient growth and is a pervading trait of human nature.’
Veblen’s theory of consumer behavior is founded upon the fact that social
status is important to people and thus affects their behavior. Likewise, for Karl
Polanyi (1944, p. 46),16 an individual is motivated ‘to safeguard his social
16
Veblen (1899, pp. 84, 85) gave an account of the dynamics of this behavior:
In modern civilized communities the lines of demarcation between social classes have grown
vague and transient, and wherever this happens the norm of reputability imposed by the upper
class extends its coercive influence with but slight hindrance down through the social structure to the lowest strata. The result is that the members of each stratum accept as their ideal of
decency the scheme of life in vogue in the next higher stratum, and bend their energies to live
up to that ideal. On pain of forfeiting their good name and their self-respect in case of failure,
they must conform to the accepted code, at least in appearance. . . . No class of society, not
even the most abjectly poor, foregoes all customary conspicuous consumption.
Veblen essentially embraced what later social thinkers such as Bourdieu (1984) and Sayer (2005)
refer to as ‘a Pascalian view of human action,’ where rational deliberation is less important than
socialization and habituation. Thus, conspicuous consumption for Veblen is not so much consciously
pursued, but the engrained practice of struggling to maintain respectability:
The Financial Crisis of 1929 Reexamined
381
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standing, his social claims, and his social assets. He values material goods only in
so far as they serve this end.’
How people are judged by others constitutes the foundation for self-esteem,
which John Rawls (1971, p. 440) claimed to be ‘perhaps the most important
primary good,’ such that without it nothing else has much value.17 As Sayer
(2005, p. 54) puts it,
The vulnerability of individuals consists in their dependence on others and not
only for material support but for ongoing recognition, respect, approval and
trust. While this may be adequately provided by small numbers of others, its
absence can cause severe distress, shame and self-contempt—indeed, sometimes
individuals may value respect more than their own lives. [Thus] recognition is
not a luxury that ranks lower than the satisfaction of material needs, but is essential for well-being.
The human preoccupation with status or relative social position is understandable from an evolutionary perspective. Those with higher status, whatever its
source, would possess disproportionate access to resources and members of the
opposite sex, thus permitting more and better-cared-for progeny. A proclivity
for seeking status would thus be naturally selected, and as Frank (2005, p. 138)
puts it, ‘falling behind ones local rivals can be lethal.’
Where there is a strong belief that vertical mobility is possible, a substantial
increase in inequality could be expected to prompt households to respond in one or
more of three ways: they might consume more of their incomes, forcing them to
save less; they might become more indebted to enable greater consumption; and
they might increase the hours they work to enable them to increase their
income and hence consumption levels. As the evidence presented below demonstrates, as a whole, US households did two, and possibly all three, during the
1920s.
4.1. Houses, Automobiles, Household Durables, and Social Status
Stricker (1983, pp. 23, 29) estimates that 35% to 40% of non-farm families lived in
poverty at the end of the 1920s, and ‘a rough estimate would be that 40 percent of
the non-farm families in the United States had insufficient incomes to buy an adequate diet at the end of the decade of prosperity’. A 1934 Brookings Institution
study found this far higher at over 70% (Leven et al., 1934). Yet many others
experienced considerable improvement in their material conditions and were
able to benefit from a revolution in household durables that greatly improved
For the great body of the people in any modern community, the proximate ground of expenditure in excess of what is required for physical comfort is not a conscious effort to excel in
the expensiveness of their visible consumption, so much as it is a desire to live up to the conventional standard of decency in the amount and grade of goods consumed (Veblen, 1899,
p. 102).
17
Veblen (1899, p. 39) made this point forcefully: ‘The usual basis of self-respect is the respect
accorded by one’s neighbors. Only individuals with an aberrant temperament can in the long run
retain their self-esteem in the face of the disesteem of their fellows.’
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382 J.D. Wisman
the quality of life. During the 1920s, the percentage of urban households with flush
toilets rose from 20% to 50%; electric lighting from 35% to 68%, vacuum cleaners
from 9% to 30%, washing machines from 8% to 24%, and ‘mechanical refrigerators’ from 1% to 8% (Lebergott, 1976, pp. 272– 288, 355; cited in Stricker,
1983, p. 7). On the one hand, these goods improved the quality of life; on the
other hand, they signaled status, and therefore their consumption was to some
extent conspicuous.
The automobile industry expanded dramatically from the beginning of the
century up until 1929, with only a couple of years of interruption during the
First World War. In 1929, over four million vehicles were produced, a level not
attained again until 1949. Two of every three families owned cars by 1929
(Livingston, 1994, p. 108).
Arguably, no single new consumer good had more transformed society than
the automobile. Its ownership signaled success and status. It made households
mobile as never before and it helped fuel a housing boom by making suburban
living more viable. Because suburban land was less expensive, housing could
be in individual units as opposed to the multi-unit apartment buildings on more
expensive in-town land.
Furniture always played a role in marking social status. However, it was generally hidden inside and thus visible only to those invited in. Free-standing houses
and automobiles opened up extraordinary potential to flash status. This was
especially true of the automobile, since it could accompany you (as had horsedrawn coaches). Olney (1991, p. 33) makes clear the importance of the advent
and spread of automobiles for household spending:
In 1899, 65 percent of durable goods spending (and 5 percent of total consumption expenditure) was for household goods, but just 7 percent (barely
.05 percent of total consumption expenditure) was for transportation goods,
and even this was mostly for horse-drawn vehicles. Thirty years later, transportation goods accounted for 36 percent of total spending for durable
goods (and 4.4 percent of total consumption expenditure), while household
goods accounted for only 51 percent (but now over 6 percent of total consumption expenditures).
A detached house reveals status better than units encased within an apartment
complex. Automobiles and free-standing houses were primary status symbols
because, as Wilkinson & Pickett (2009, p. 225) point out, ‘research confirms
that the tendency to look for goods which confer status and prestige is indeed
stronger for things which are more visible to others.’
During the 1920s, as the wealthy received larger shares of total income,
they bought more expensive houses, vacation properties, automobiles, country
club memberships and other luxury items. Automobiles made possible the dramatic expansion of private playgrounds for the rich—so-called country clubs.
The real estate boom was especially robust in vacation facilities such as
hotels, tourist cottages, and motor courts (Grebler et al., 1956). The fact that
in 1929, the top 1% of the income distribution had 80% of total household
savings and the top decile had 86% means that the 9% just below the top
1% accounted for only 6% of total saving. This suggests that consumption
The Financial Crisis of 1929 Reexamined
383
competition was especially intense among the top decile elite (Hall & Ferguson,
1998, p. 18; Stricker, 1983 –84, p. 50). Eighteen percent of families owning
automobiles had more than one (Stricker, 1983, p. 30). This consumption
arms race put pressure on those with lower incomes to consume more to maintain their relative social standing.
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4.2. Weak Supervision and Financial Innovations
Financial innovations such as ’shoestring mortgages’ enabled property to be
bought on margin. White (2008, p. 34) notes that ‘ . . . weakening supervision
by the banking regulators contributed to the increase in easy finance that fueled
the boom.’ The expansion of credit unhinged the traditional relationship
between income and spending (Olney, 1991, pp. 130– 131). Other forces also
eroded the Protestant virtue of frugality and taboos against consumer credit.
Most notable was the decline of traditional sources of social certification and
status that accompanied the deskilling of work and the decline of communities,
just as technology and higher incomes made possible a consumer durables revolution. As traditional communities waned, and how well and hard one worked
became less visible with the rise of factories, how much one could consume
became increasingly a gauge of how hard one worked, prompting households to
seek social certification through consumption.18
A ‘boom in post-World War I advertising’ (Olney, 1991, p. 169) kept the
rising consumption of the wealthy on display. ‘In the 1920s, advertising’s pictorial
images portrayed the comforts and luxuries of the well-to-do while advertising’s
words promised everyone access to these things . . . During the Coolidge era, corporate elites advertised the “Democracy of Goods” and urged every citizen to
partake of the pleasures offered by the new and exciting mass popular culture’
(Edsforth, 1998, pp. 260, 266).
As inequality increased during the 1920s, households struggled to maintain
their relative status through reduced savings,19 greater indebtedness, and possibly more work hours. Between the periods 1898– 1916 and 1922– 1929, personal saving as a percentage of disposable income declined 42%—from 6.4%
to 3.8%. Olney (1991, pp. 48– 49) notes that this ‘is astounding, particularly
since the 1920s were rather prosperous years and we usually expect saving
rates to climb, not fall, during periods of prosperity.’ The argument set forth
18
Thus the Protestant work ethic survived, but not the ascetic ethic (Wisman & Davis, 2013).
This argument is the opposite of that of Keynes (1936, pp. 372–375), for whom increased in
inequality would be expected to increase saving since wealthier households have higher marginal
propensities to save than those less-well off. Keynes failed to take into account how rising inequality
pressures households beneath the top to increase consumption in order to maintain their relative
social status. Yet Keynes (1932, p. 365) obliquely recognized consumption externalities in his delineation of two classes of human needs, ‘those needs which are absolute in the sense that we feel them
whatever the situation of our fellow humans may be, and those which are relative in the sense that we
feel them only if their satisfaction lifts us above, makes us feel superior to, our fellows.’ However,
his view that greater inequality would decrease consumption does not concord with this distinction
between absolute and relative needs. For an extended discussion of the manner in which Veblen’s
theory of consumer behavior clarifies US saving behavior, see Brown (2008) and Wisman (2009).
19
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384 J.D. Wisman
here is that this ‘astounding’ decline is in part due not only to attractive new
consumer durables, but also to consumption externalities resulting from rising
inequality.
In struggling to maintain their relative status in the face of rising inequality,
debt increased from 4.64% of income in 1919 to 9.34% in 1929 (Olney, 1991,
pp. 88– 89), rising from $3 billion in 1920 to $7.2 billion in1929 (Bernstein,
1998, p. 194). ‘By 1930, installment credit financed the sales of 60 –75 percent
of automobiles, 80–90 percent of furniture, 75 percent of washing machines, 65
percent of vacuum cleaners, 18 –25 percent of jewelry, 75 percent of radio sets,
and 80 percent of phonographs’ (Calder, 1999, p. 201). Between 1921 and
1929, consumer spending on durables grew 116%, whereas spending on non-durables grew by 34% (Hall & Ferguson, 1998, p. 19). This increased indebtedness
took place against a deep Protestant aversion to debt and to consumption
beyond necessities.20
This rise in indebtedness fits the Veblenian hypothesis that in a society in
which vertical mobility is believed to be highly fluid, increasing gaps in income
all along the spectrum stimulate everyone to struggle harder to meet their consumption status targets, as those at the very top compete among themselves for
the very pinnacle of status.
Inequality did not explode in other countries that would also fall into
depression. Romer (1993, p. 22) notes that a ‘feature of the American experience
in 1930 was that the initial fall in industrial production was more concentrated in
consumer goods and less concentrated in investment goods than in many other
countries.’ Households reached the limits of their indebtedness and were unable
to meet their debt obligations.
A third way to maintain relative social standing in the face of rising inequality would be to work longer hours. Although the work week continued contracting
during the 1920s, female labor force participation rates increased from 24.3% to
25.1% (Smiley, 2010, p. 4). ‘New expectations regarding appropriate family
income levels . . . encouraged more women to enter the labor market’ (Bernstein,
1998, p. 195). Support is suggested by a study of more contemporary American
society in which married women are found to be more likely to enter the labor
market where there is greater inequality in men’s incomes (Park, 2004). It is
also supported by a transnational study finding ‘that increased inequality
induces people to work longer hours [and] . . . the underlying cause is the
Veblen effect of the consumption of the rich on the behaviour of those less well
off’ (Bowles & Park, 2005, p. F410). More generally, Huberman & Minns
(2007) find that inequality was a strong predictor of average working hours at
the national level during this time.
20
Ayres wrote in 1926 that prior to the twentieth century, ‘ . . . the things that a self-respecting thrifty
American family would buy on the installment plan were a piano, a sewing machine, some expensive
article of furniture, and perhaps sets of books. People who made such purchases didn’t talk about
them. Installment buying wasn’t considered quite respectable’ (cited in Olney, 1991, pp. 130–
131). Bell (1996, p. 38) characterizes ‘the invention of the installment plan [as] the most “subversive” instrument that undercut the Protestant ethic . . . [and] Marketing and hedonism became the
motor forces of capitalism.’
The Financial Crisis of 1929 Reexamined
385
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5. Resource Command and Ideology Control
The political pendulum swung dramatically toward laissez-faire ideology and
against labor between the First World War and 1929.21 Although ideological
shifts are complex, a number of factors underlying this swing stand out. Most
notable was the ease with which labor’s failure to fulfill its informal wartime
‘no strike’ pledge could be depicted as unpatriotic at a time when the Russian Bolsheviks were introducing an alternative to capitalism. In a ‘Red Scare’ environment, labor’s struggles were portrayed as part of a communist conspiracy to
turn the United States into a Western version of the Soviet Union, while business
interests embarked on a campaign to demonstrate the patriotism of business22 and
the dangers of labor’s intransigence.
Reinforcing this ideological shift, rising inequality meant that the very rich
had more resources to influence public opinion and policy. As Perelman (2007,
p. 112) notes, ‘only the rich and powerful have the resources to mount strong lobbying efforts, which bring them even more wealth and power, enabling them to
lobby even more effectively.’23
Given their education and command over economic resources, it is understandable that the rich would learn to craft their ideologies so that they become
ever-more convincing to a majority of the electorate. Their disproportionate
control over the media, educational institutions and think tanks made this
outcome inevitable. As they received larger shares of national wealth and
income, this process sped up. Moreover, research has demonstrated that expenditures on creating and disseminating ideology promise high returns (Glaeser &
Saks, 2006; Glaeser, Scheinkman, & Shleifer, 2003).
5.1. The Surge of Laissez-Faire Ideology during the 1920s
The 1920 election returned control of the federal government to the Republican
Party. ‘Business-oriented Republicans dominated national politics and lobbying
efforts in Congress . . . and nativism shaped political debates all over the
country. Longstanding white Protestant movements to impose Prohibition and
restrict immigration finally had succeeded in the Coolidge era’ (Edsforth, 1998,
p. 246). For Keller (1984, p. 133), ‘the twenties were a “fabled interlude” of
moving away from governmental controls and moving toward a laissez-faire,
pro-business, orientation of federal government.’
It was widely claimed that the American free-enterprise system promoted
the values of ‘social harmony, freedom, democracy, the family, the church, and
21
Hirschman (1982) finds political ideology to be cyclical. The 1920s support this hypothesis. In the
1912 Presidential election, 75% of the vote went to candidates who called themselves ‘progressive’
or ‘socialist.’ Hundreds of socialists were elected between 1880 and1920 (Keyssar, 2000).
22
A leader of the National Association of Manufacturers proclaimed that ‘Business and patriotism
go hand in hand. Industrialism is beneficent, civilizing and uplifting. It is the enemy of war, of
despotism, of ignorance and poverty. In truth, its foes are the foes of mankind‘ (cited in Watts,
1991, pp. 28– 29).
23
Following Thompson (1991, p. 73), ideology is understood as ‘ways in which meaning is mobilized in the service of dominant individuals and groups.’
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386 J.D. Wisman
patriotism.’ Advocates of ‘government regulation of the affairs of business’ were
characterized as subversive (Carey, 1995, p. 27). Moreover, ‘Business control of
government, so marked throughout the decade of the 1920s, made the regulation
of business by government a farce’ (Hicks, 1960, p. 232). Although the second
great American merger movement occurred during the second half of the
1920s, little response came out of the Justice Department. By 1929, about half
of all corporate wealth was controlled by 200 corporations (McElvaine, 1981,
p. 37). Price fixing, although illegal, also brought little response (Smiley, 2010,
p. 11).
The first major blow to labor’s power came with the breaking of a strike in the
steel industry in 1919. Thereafter, Ohanian (2009, p. 2320) notes, ‘Prevention
methods included company unions and modest corporate welfare programs that
are widely perceived to have kept unions out of the workplace, and the use of violence when unions attempted to organize or when workers called a strike.’ Tactics
used ‘included kidnapping union organizers, firing workers who met with organizers, evicting strikers from company-owned homes, denying medical care to
striker families from company-directed health providers, and beating and shooting
strikers.’ There was also widespread use of ‘yellow-dog’ contracts requiring
employees to agree not to join unions. Company-controlled unions increased
from 145 in 1919 to 432 in 1926 (Smiley, 2010, p. 5).
With labor unions viewed negatively, the courts issued as many anti-labor
injunctions during the 1920s as during the entire period from 1880 to 1920 (Bernstein, 1966, 1998). The Supreme Court ruled minimum wage legislation in the
District of Columbia unconstitutional in 1923. Undergirding these court decisions
was the doctrine of ‘freedom of contract.’ ‘Radical organizations were effectively
repressed, and almost every union affiliated with the American Federation of
Labor was put on the defensive‘ (Edsforth, 1998, p. 247).
A new media technology, the radio, assisted the dissemination of ideology.
The first radio broadcast took place in November 1920. By 1923 more than 500
radio stations operated in the US; 550,000 radio sets were sold that year. By
1928, 12 million sets catered to 40 million listeners (Blanning, 2008, pp. 204 –
205). Because radio stations depended on advertising, they were beholden to
the business point of view.
So completely did business dominate the climate of opinion during the 1920s
that Roger Babson claimed it had conquered ‘the press, the pulpit and the schools’
(Cochran & Miller, 1942, pp. 343–344). In academia, ‘trustees and presidents in
cooperation with the business community set up spy systems in their universities
and colleges to identify the radical, un-American professors and students for dismissal; and a movement was launched to scrutinize economic textbooks for
breaches of loyalty’ (Lee, 2009, p. 31).
Progressive academic economists were harassed and often forced out.
‘[E]conomics departments with too many progressives (as at the University of
Washington) were restructured and placed in conservative business schools; and
businesses threatened not to donate to universities that retained faculty with
radical economic views’ (Lee, 2009, p. 31). Not surprisingly, academic economists provided increasing support to free-market ideology, lending support to rightwing policies, even when this was not their intent. The mainstream economic
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The Financial Crisis of 1929 Reexamined
387
canon was highly supportive of unfettered, and thus unregulated, markets, even
when the consequence was greater inequality.24
Because the wealthy increased their command over society’s ideology, the
losers—the overwhelming majority of Americans—could not use the political
process to stop the super-rich rip-off. Through the democratic process, in principle, they could have gotten compensatory measures enacted to relieve
workers harmed by technological change or international trade.25 Taxes could
have been restructured in their favor, and public services that benefit them such
as day care, better schools, health care and public recreational facilities could
have been vastly expanded and improved. However, the elite’s increased
control over ideology resulted in the majority buying into the ideology of the
wealthy that such measures would not be to either their own benefit or the country’s benefit.
6. Final Reflections
Rising inequality has long been dismissed as either irrelevant or as missing the
economic dynamism that inequality generates. A broader understanding,
however, reveals the myriad ways inequality is central to economic processes
and how rising inequality can set the stage for severe systemic dysfunction. A
Keynesian/Kaleckian perspective reveals how rising inequality may result in a
rich elite directing investment from the real economy into financial speculation,
with a portion of it recycled as debt to those struggling to keep up. Veblen’s
theory of consumer behavior clarifies the manner in which rising inequality
may create consumption externalities, prompting households to save less, take
on more debt, and perhaps work longer hours in their struggle to maintain relative
social respectability and self-respect. Marx’s theory of ideology explains how
rising inequality enables elites to gain control over economic and political ideology. An economic science worthy of its name needs to be capable of maintaining a
tool box containing the full richness of the discipline’s theoretical perspectives.26
After a Keynesian interlude between the 1930s and 1970s, during which there
was an appreciation of broader approaches, economics became increasingly formalized and narrow. Moreover, it increasingly depicted a tradeoff between
growth and equity,27 where the study of inequality came to be seen by some as
unnecessary. The 1995 recipient of the Nobel Memorial Prize in Economic
Sciences even went so far as to declare that ‘Of the tendencies that are harmful
24
For a discussion of how economics has legitimized inequality, see Wisman & Smith (2011).
Government is important in determining income distribution, wealth and privilege. As Jencks
(2002, p. 52) puts it, ‘Almost everyone who studies the causes of economic inequality agrees that
by far the most important reason for the differences between rich democracies is that their governments adopt different economic policies.’
26
This point was made by Kindleberger (1996, p. 201): ‘the economist who resorts to only one model
is stunted. Economics is a toolbox from which the economist should select the appropriate tool or
model for a particular problem.’
27
Recent scholarship finds that greater income inequality leads to slower economic growth (Alesina
& Rodrik, 1994; Easterly, 2002; Persson & Tabellini, 1994).
25
388 J.D. Wisman
to sound economics, the most seductive, and in my opinion the most poisonous, is
to focus on questions of distribution’ (Lucas, 2004).
Because economics has underestimated the importance of inequality, it failed
to capture its importance in setting the stage for the financial crisis of 1929 and the
depression that followed. Consequently, it could not learn from that episode and
foresee that the same phenomenon was repeating itself, leading up to the financial
crisis of 2008 (Wisman, 2013; Wisman & Baker, 2011). This has been a costly
unlearned lesson.
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Acknowledgments
Helpful comments from Mary Hansen and two anonymous referees are gratefully
acknowledged.
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